“It takes courage to be a pig,” is Stanley Druckenmiller’s motto. He has a yellow porcelain pig named Jerome sitting on his desk to remind him of this.
Druckenmiller is one of the best currency traders of all time but a lot of people probably have no idea who he is. His net worth as of March 2013 is 2.8 billion dollars. Forbes has Stanley Druckenmiller listed as the 168th richest person in America. He has a fleet of over 12 different vehicles that are kept at his home at Southampton. He owns a multi-million dollar business jet, a Bombardier Global Express BD-700.
From 1988 to 2000, he managed money for George Soros as the lead portfolio manager for the Quantum Fund.
His most infamous trade is his bet against the Pound in 1992. While most people credit the trade to Soros, the actual idea came from Druckenmiller, Soros only encouraged him to take a bigger position.
Stanley Druckenmiller with Soros in the background
George Soros encourages Stanley Druckenmiller to trade bigger
Druckenmiller recalls how Soros pushed him to trade bigger:
‘’As an example, shortly after I had started working for Soros, I was very bearish on the dollar and put on a large short position against the Deutsche mark. The position had started going in my favor, and I felt rather proud of myself. Soros came into my office, and we talked about the trade’’.
"How big a position do you have?" he asked.
"One billion dollars," I answered.
"You call that a position?" he said dismissingly. He encouraged me to double my position.
I did, and the trade went dramatically further in our favor. Soros has taught me that when you have tremendous conviction on a trade, you have to go for the jugular. It takes courage to be a pig. It takes courage to ride a profit with huge leverage. As far as Soros is concerned, when you're right on something, you can't own enough.
But let us start at the beginning, at the time a trading legend was born.
Black (Golden) Wednesday
September 16th 1992 is also known as Black or Golden Wednesday in Britain, depending on who you talk to. It was the day the Pound Sterling was forced out of the ERM (European Exchange Rate Mechanism).
The ERM was a system devised by the predecessor of the European Union, the European Community. The purpose of the system was to reduce volatility in exchange rates and to prepare the different European currencies for entry into the new European currency, the Euro.
There was a long standing debate in Britain on entering the ERM. The camp in favour of joining the ERM argued that it would turn the British economy into a low inflation economy and lead to German style prosperity.
The opponents argued that the ERM would become UK’s “economic prison” locking the country to Germany’s monetary policy. If Germany raised interest rates Britain would have to follow suit in order to avoid pressure on its currency, with no regard to its own economic situation. Britain would have to mirror the higher rates even if the country was in the middle of a downtrend and was in need of lower interest rates.
Britain enters the ERM at 2.95 versus the Deutsche Mark without consulting the Bundesbank
Britain entered the ERM in October 1990 at 2.95 Deutsche Marks to the pound. If the exchange rate neared the bottom of its permitted range, 2.778, the government would have to intervene. UK inflation was raging at the time, going at a rate of three times of Germany's, and UK Interest rates were already at a very high level of 15% at the time of entry. This made it hard from the start to maintain the inflated level of the Pound versus the German Mark.
The usual procedure of joining the ERM involved a long process of negotiations and consultation with the German Bundesbank. But Margaret Thatcher, the prime minister of the United Kingdom at the time, disregarded this process and went at it alone.
Thatcher disregards the Bundesbank and acts alone
Karl Otto Pohl, the Bundesbank President at the time recalls the heated phone call he had with Britain’s chancellor John Major:
John Major called me and said ‘’We have decided to join the ERM at the rate of 2.95 D Marks’’. I said John I have to tell you we have to negotiate that and I think 2.95 is a little bit on the high side.
He said ‘’No we cannot change that because it was decided by the Prime Minister’’.
I said I don’t care about your Prime Minister but I wanted to negotiate that with you, you have to follow the rules’’. He said ‘’It’s too late now, we will announce it’’.
And after it was announced of course there was no room for negotiations’’.
In his comments to the press right after the announcement John Major didn’t hide his satisfaction with the decision. He was quoted as saying ‘’This is a great day for Britain’’ and ‘’I think it will a great success’’.
Joining the ERM didn’t save Thatcher’s career, a victim of a coup in her party, she was forced to resign as Prime Minister. John Major took her place.
John Major replaces Margaret Thatcher
Over the next 18 months Britain’s economy got lot worse
The housing boom that was in the process of busting intensified and over a million people lost their jobs. The high exchange rate made it harder for UK’s businesses to sell their goods abroad.
Despite all this however John Major won the elections in April of 1992 and was determined to stay the course.
Andrew Neil editor of the Sunday Times recalls a dinner meeting with the Prime Minister right after the election. John Major repeated his vision of turning Britain into a low inflation economy like Germany. He said:
‘’You know Andrew, Prime Ministers have tried to get inflation down and make Britain a low inflation economy, they’ve never succeeded. I’m going to do it, I’m going to be the Prime Minister that got inflation down and established Britain as a low inflation economy’’.
Andrew replied ‘’But what’s the point of low inflation if the economy’s dead? Anybody can do that’’.
An angry John Major thumbed the table and replied that this is a policy on which he would never give way, the pain was worth it. There was no alternative, he added.
July 16th 1992, the Bundesbank increases the pain
As the German Bundesbank was convening for its monetary policy meeting, Germany’s economy was in trouble. The cost of the reunification of West and East Germany was rising and so was inflation. Staying loyal to its inflation fighting mandate, the Bank raised interest rates.
Now it was Britain’s turn. The country was supposed to mirror Germany’s decision and raise interest rates. But with Britain’s economy faltering and its housing market in the bust phase, the government was desperately trying to avoid raising rates. This caused the Pound to sell off toward its lower range with the Deutsche Mark. Rumors spread that the government was going to devalue the pound and set a lower exchange rate with the D Mark.
Druckenmiller sells $1.5 billion worth of Sterling versus the German mark in August of 1992
He expected the ERM, Europe’s exchange-rate mechanism, to come under pressure as Germany raised interest rates to prevent inflation after the reunification between West and East Germany. Germany’s move forced other ERM members to decide whether to also raise rates, which might slow down their economies, or devalue their currencies and fall out of the ERM.
Druckenmiller said that he calculated the Bank of England didn’t have enough reserves to prop up the currency and it couldn’t afford to raise rates.
In the meantime, Britain government was desperately trying to restore market confidence. On August 26th 1992, Norman Lamont, Britain’s Chancellor made the following statement:
‘’Just in case there is even the slightest scintilla of doubt, there will be no devaluations, no leaving the ERM. We are absolutely committed to the ERM, that is our policy, it is at the centre of our policy. We’re going to maintain Sterling’s parity and we will do whatever is necessary’’.
Norman Lamont tries to reassure jittery markets
Unwilling to devalue the Pound or raise interest rates, the only option left for the British government was to ask the Germans to lower their interest rate.
September 4th 1992
Europe’s Finance Minister and Central Bankers gather in London for a meeting. Norman Lamont’s job was to convince Helmut Schlesinger, the President of the Bundesbank, to lower rates. Britain wasn't the only one suffering. Other countries were feeling the pain of having to follow Germany’s path to higher interest rates. They felt something had to be done, otherwise they would have to leave the ERM.
(we've reached the 1,500 word limit, Part 2 coming up next week)